CONSTRUCTION - Plenty of macro and operational challenges

Investment Highlights 

• We maintain our NEUTRAL recommendation for the construction sector. On one hand, we acknowledge that the trading sentiment on construction stocks has improved following the government announcement that the MRT3 project will commence work during 2H 2021. On the other hand, macro and operational challenges remain aplenty in the sector. These include high national debt weighing on the government’s ability to roll out public projects, a 12th Malaysia Plan that has yet to be revealed, a dynamic political landscape, mega projects that have lost their shine, intensifying competition (as both public and private projects dry up amidst the growing presence of foreign contractors, especially large state-owned Chinese contractors), higher operating cost and risk, lower efficiency and supply chain disruptions as Covid-19 rages on.
   
• High national debt: Fitch Ratings in Dec 2020 downgraded Malaysia’s long-term foreign-currency issuer default rating to ‘BBB+’ from ‘A-‘, on the heels of S&P Global Ratings’ June 2020 downgrade of Malaysia’s outlook to negative from stable. This leaves the government with very limited room for fiscal manoeuvre. Also, for fiscal measures, we believe the government’s focus gravitates towards cash handouts vs. the rollout of public projects, as the impact of the former on the economy is immediate, while the latter takes time to get off the ground and bring about the multiplier effect throughout the economy. While the financial market is hopeful on the announcement of a large-scale pump-priming exercise by the government, local contractors have wasted no time in venturing or returning to overseas markets, including Sunway Construction (India), Gamuda (Australia) and Econpile (Cambodia).
   
• Dynamic political landscape: There is a strong likelihood of the 15th general election being called immediately after the lifting of the state of emergency on 1 Aug 2021. As mega public infrastructure projects typically take 3–5 years (or even up to 7–10 years) to complete, ongoing projects could be derailed in the event of a change in power during their construction periods.
   
• Mega projects less impactful, unattractive risk-return: Also, the construction period of mega projects may be prolonged to lighten the stress on the government’s cash flow. This means the earnings impact (progress billings per annum) will be significantly lower vs. if the projects are to be fast-tracked. In addition, the implementation model is gravitating towards a public-private partnership where the main contractor may be required to take on certain operating/commercial risk (East Coast Rail Link) and/or participate in the funding of the project (Island A of Penang Transport Master Plan). For the MRT3 project, there has been indication that up to 30% of the project cost will come from “private funding”.
   
• Higher cost and risk but lower productivity and efficiency: Players have to incur additional expenses to comply with the Covid-19 prevention SOP and the upgrading of the dormitory for foreign workers in compliance with the Workers’ Minimum Standards of Housing and Amenities Act 1990, also known as Act 446. They operate at sub-optimal productivity and efficiency given the restriction on working hours and worker density on the site, and due to the time-off during the frequent inspection by the enforcement officers. There could potentially be a stop-work order or enhanced movement control order on the construction site or dormitory in the event of Covid-19 infections.
   
• We may upgrade our NEUTRAL call on the sector to OVERWEIGHT if the government decides to forge ahead with the implementation of key public infrastructure projects despite the weak fiscal position. Conversely, we may downgrade our NEUTRAL call on the sector to UNDERWEIGHT if the MRT3 project fails to get off the ground as planned or key ongoing mega projects are suspended.

As you can see, the AmInvestment Bank is slightly upbeat on the construction sector. Personally, I selected KERJAYA, HSL, as well as AGES due to its low valuation. Do feel free to comment your thoughts for discussion!